Will Fiscal Stimulation Work? [Or Were the Austrians Right?]

January 25, 2009

With most of the major governments on earth planning large spending increases, and most economists in favour, it must still be noted that there are a number of commentators who oppose these measures. They do so for a variety of reasons, some practical, some analytical and some ideological.  

This debate of course returns focus to the “Austrian” School, a body of thought that argues against the effectiveness of governmental intervention in the economy.  From this point of view, individuals should make their own decisions with only minimal interference.  This view does not representthat of mainstream economics.  Essentially, it is an assertion, with little empirical evidence to back it up.  They can draw attention to examples of governmental intervention that failed spectacularly; but there are equally compelling examples of where it works.

While the non-interventionists are fond of  historical analysis, they seem oblivious to the history of commerce.  Again and again, in societies recent and long past, unregulated markets boom and then collapse.  Some of the earliest European markets gained competitive advantage by enforcing standards of weights and measures.  Indeed, market participants have long sought out regulated markets precisely because they facilitate exchange.   

Ironically enough, while the non-interventionist approach calls for maximum individual freedom, they do it in the name of group welfare.  Individuals working according to their own inclinations produce a continually advancing society. The cost of individuals who are trashed by market failures apparently carries little concern. 

There are two key objections to this non-interventionist view. First, significant levels of intervention, well beyond what the Austrians would recommend, are the long established norm of the industrial world. However, over the past century, the world has seen a historically unprecedented rise in individual and social prosperity.  Moreover, the benefits of a rising standard of living are now being shared more widely.  In other words, the present model of appropriate intervention works.

Second, the non-interventionist seems oblivious to the fact that individual decisions are very often affected by ignorance, misinformation and fraudulent intent. Individuals are quite capable of making decisions that harm them and others in their society.  Apparently we are just supposed to learn from these mistakes and make better decisions tomorrow.  But some mistakes are catastrophic, like those affecting the environment.  And there are mistakes from which recovery is impossible.

Of  course governmental intervention can be unwise.  It too can produce disastrous results. It can  be corrupted and reward the lazy or the greedy.  And on occasion, it may simply not work.  But this is not a generic argument against intervention.  It is a argument to think very carefully, plan very carefully and learn from experience.  Thisis a messy process, like the reality with which we all cope.  The non-interventionist seeks a simple single answer, a magic incantation to make reality less real.

Again and again, in issue after issue, there is the futile pursuit of a single answer to the complex challenges of our world.  And so some claim that If only money were backed by gold, we would eliminate global poverty! The beguiling lure of the simple and easy will be with us for a long time yet.

The majority view is that large scale stimulation is necessary since the banking system has been so badly impaired.  It would be dangerous and produce great social disadvantage to just wait for the banking system to be re-constituted, as it must. Therefore, whenconsumers and business reduce their spending, goverment leans against the trend and increases its spending. The logic is rock solid.

The principal scholarly objection to this increased spending is that it may crowd out business spending. but it cannot crowd out has has already fallen. Of course, as it economy revives, crowding out becomes a real danger.  And future inflationary pressures are also a concern. But that just means that these stimulations need to be reversed quickly as circumstances change.

Given the haste and scale of the spending underway [together with the other financial assistance to the banks], money will surely be wasted and/or spent to no purpose.  But this is the price we must pay for the meltdown of the financial sector.

The analogy is overworked, but it stands. When the house is ablaze, pour water everywhere to put out the flames.  Then the hard part begins: pump out the basement and repair the structural damage.